Submitted by Michael Every of Rabobank
I can’t recall how long I have been banging on about rising geopolitical risks and how these presented a myriad of pressure points, any one of which ‘breaking’ would see markets move wildly. Well, it seems that one of the most old-fashioned and predictable of these, Middle East tensions, has re-emerged literally with a bang: over the weekend there was what was either a drone or a missile attack on key Saudi oil facilities that may have taken down up to 50% of output. The crown jewel of the Saudi oil industry has just been shown to be highly vulnerable to attacks that might have been carried out by low-cost, low-tech drones that will be almost impossible to prevent from occurring again.
The market implications speak for themselves: Brent surged 21% in early trading, the biggest intra-day move since 1991. (Which also involved the Middle East, of course.)
US Secretary of State Pompeo has already stated that Iran was behind this attack, while US President Trump has tweeted “there is reason to believe that we know the culprit, are locked and loaded depending on verification, but are waiting to hear from the Kingdom as to who they believe was the cause of this attack, and under what terms we would proceed!” Knowing the deep, bitter, and long-standing Saudi-Iranian rivalry, whom do you suppose Riyadh will point the finger at here now it gets to do so?
If it is Iran, or Iran acting from Iraq…expect real regional fireworks. A 21% move in Brent might be small in those circumstances.
If it is the Houthis in Yemen (albeit backed by Iran) this would be a sign that the US and Saudis are not looking for full escalation at this moment. Yet is that likely now that the Saudi and global oil complex has been directly targeted? And, geopolitically, will the US still be willing to meet with Iran now that is has upped the ante…or will it be forced to by this ‘crude display’ of regional force?
We face sharply binary potential outcomes, and Trump has already tweeted that it is “Fake News” that he was willing to meet the Iranian president with no preconditions. Yes, we have ridden through lots of these kind of issues of late, and each time all returns to normal and markets have ended even higher. But if that doesn’t occur here in the world’s leading oil complex then the other scenario is terrifying. Do you really want to go Risk On today?
Back to markets. Trump has also announced the release of oil from the US strategic petroleum reserve, which the market was perhaps expecting given that the spike of 21% had already been moderated to “merely” 13%. Nonetheless, against this backdrop there is surely going to be a higher geopolitical risk premium built into the entire Middle East oil complex until matters are properly resolved.
What does that mean for other markets? Knee-jerk it is risk-off FX will stay better bid (JPY, CHF,…USD?); oil exporters will benefit (RUB); and oil importers will suffer (INR, etc.) And how about for central banks and rates markets? Consider that despite the fact that the markets--like ourselves, but later to the party--still see plenty more rate cuts coming ahead, recent US data, including last Thursday’s CPI and Friday’s retail sales, helped see a huge swing in 10-year yields. In the US this was from 1.47% to 1.90% despite the fact that the Fed is tipped to cut 25bp to 2.0% this week alone.
If we now have a threat of Middle East war and a much higher oil price, albeit with a lag once the strategic reserve has been depleted, where does that leave our monetary guardians? Will they really be worrying about oil pushing us into a wage-price spiral now that unemployment is so low – in which case rates need to rise, and devil take the stock and housing markets? Or will they see that in a globalised world a higher oil price is a lower real wage for most workers, in which case the stock and housing markets are already going to take a hit and will need the support of lower rates? I wager the latter: in which case, the almighty yield swing we saw last week is likely to be partially reversed immediately – on a risk-off basis alone.
Indeed, even before this all transpired there were other risks that pointed in the same direction. For example, with recent US data suggesting that the US economy is doing fine, surely the odds were rising on Trump needing to stir the pot on the trade-war front in order to ensure that rates come down as quickly as he would like? If this oil shock doesn’t do the trick, that trade shock will have to. Again, that is crude real politik – but welcome to the real world.
Meanwhile, other headlines today also don’t line up with the sunny market assessment we saw priced in last week.
In the UK we have heard suggestions that the next trick for the ‘Rebel Alliance’ in Parliament will be to push for the full repeal of Article 50 – on the premise this whole Brexit matter needs to simply be “sorted out”, and then the “real business” of politics can continue “as normal”. Yet genies rarely go back into bottles like that and Brexit increasingly IS politics as the UK party system breaks down. Indeed, an opinion poll published yesterday shows the Tories, despite bleeding members to the Lib Dems and suffering the worst press of any administration in memory, are widening their lead with 37% support to Labour’s 25% and the Lib-Dem’s 16%. The Brexit Party still has 13%, meaning half the voting public is in favour of the (off-the) cliff-edge tactics being pursued. PM Johnson has pledged to defy a parliamentary no-deal ban if he cannot get a deal,…and has compared himself to The Hulk--who gets stronger the madder he gets--wanting to break the chains of the EU: that the day before he sits down to discuss Brexit with Jean-Claude Juncker. How crude this is too.